QUARTERLY REPORT
PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For
the quarterly period ended June 30, 2017

or

¨

TRANSITION
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For
the transition period from to

Commission
file number: 0-31641

SCI
ENGINEERED MATERIALS, INC.

(Exact
name of registrant as specified in its charter)

Ohio

31-1210318

(State
or other jurisdiction of

(I.R.S.
Employer

incorporation
or organization)

Identification
No.)

2839
Charter Street, Columbus, Ohio 43228

(Address
of principal executive offices) (Zip Code)

(614)
486-0261

(Registrant’s
telephone number, including area code)

Not
Applicable

(Former
name, former address and former fiscal year, if changed since last report)

Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x
No ¨

Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every
Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (section 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files). Yes x No ¨

Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller
reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate
by check mark whether the registrant is an emerging growth company as defined in Rule 405 of the Securities Act of 1933 (17 CFR
230.405) or Rule 12b-2 of the Exchange Act of 1934 (17 CFR 240.12b2).

Emerging
growth company ¨

If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨
No x

4,139,544
shares of Common Stock, without par value, were outstanding at August 2, 2017.

The
accompanying notes are an integral part of these financial statements.

3

SCI
ENGINEERED MATERIALS, INC.

BALANCE
SHEETS

LIABILITIES
AND SHAREHOLDERS' EQUITY

June
30,

December
31,

2017

2016

(UNAUDITED)

Current Liabilities

Capital
lease obligations, current portion

$

135,778

$

121,383

Notes payable,
current portion

195,811

172,408

Accounts
payable

352,276

151,757

Customer
deposits

1,721,224

249,977

Accrued
compensation

77,068

89,826

Accrued
expenses and other

124,707

120,943

Total
current liabilities

2,606,864

906,294

Capital lease obligations,
net of current portion

245,712

225,944

Notes
payable, net of current portion

112,179

221,105

Total
liabilities

2,964,755

1,353,343

Commitments and contingencies

Shareholders' Equity

Convertible
preferred stock, Series B, 10% cumulative,

nonvoting,
no par value, $10 stated value, optional

redemption
at 103%; optional shareholder conversion 2 shares for 1;

24,152
shares issued and outstanding

502,362

490,286

Common stock, no par value,
authorized 15,000,000 shares;

4,135,427
and 4,090,804 shares issued and outstanding, respectively

10,087,308

10,049,823

Additional
paid-in capital

2,241,505

2,193,536

Accumulated
deficit

(10,432,642

)

(10,461,515

)

2,398,533

2,272,130

TOTAL
LIABILITIES AND SHAREHOLDERS' EQUITY

$

5,363,288

$

3,625,473

The
accompanying notes are an integral part of these financial statements.

4

SCI
ENGINEERED MATERIALS, INC.

STATEMENTS
OF OPERATIONS

THREE
MONTHS AND SIX MONTHS ENDED JUNE 30, 2017 AND 2016

(UNAUDITED)

THREE
MONTHS ENDED JUNE 30,

SIX
MONTHS ENDED JUNE 30,

2017

2016

2017

2016

Revenue

$

1,911,498

$

1,206,484

$

3,283,414

$

2,581,296

Cost of revenue

1,448,651

919,625

2,483,582

2,034,827

Gross profit

462,847

286,859

799,832

546,469

General and administrative
expense

256,112

273,712

510,550

563,440

Research and development
expense

79,175

74,417

161,787

154,493

Marketing
and sales expense

46,581

104,832

75,470

213,842

Income (loss) from operations

80,979

(166,102

)

52,025

(385,306

)

Interest

(10,710

)

(11,156

)

(22,204

)

(22,841

)

Income (loss) before
provision for income taxes

70,269

(177,258

)

29,821

(408,147

)

Income
tax expense

(948

)

(43

)

(948

)

(43

)

Net income (loss)

69,321

(177,301

)

28,873

(408,190

)

Dividends
on preferred stock

(6,038

)

(6,038

)

(12,076

)

(12,076

)

INCOME
(LOSS) APPLICABLE TO COMMON SHARES

$

63,283

$

(183,339

)

$

16,797

$

(420,266

)

Earnings per share -
basic and diluted (Note 6)

Income (loss) per common share

Basic

$

0.02

$

(0.05

)

$

0.00

$

(0.10

)

Diluted

$

0.02

$

(0.05

)

$

0.00

$

(0.10

)

Weighted average shares outstanding

Basic

4,125,880

4,042,722

4,114,756

4,033,488

Diluted

4,125,880

4,042,722

4,114,756

4,033,488

The
accompanying notes are an integral part of these financial statements.

5

SCI
ENGINEERED MATERIALS, INC.

STATEMENTS
OF CASH FLOWS

SIX
MONTHS ENDED JUNE 30, 2017 AND 2016

(UNAUDITED)

2017

2016

CASH
FLOWS FROM OPERATING ACTIVITIES

Net
income (loss)

$

28,873

$

(408,190

)

Adjustments
to reconcile net income (loss) to net cash provided by operating activities:

Depreciation
and accretion

229,552

221,537

Amortization

4,719

4,719

Stock
based compensation

97,531

105,103

Gain
on disposal of equipment

-

(750

)

Inventory
reserve

-

10,509

Changes
in operating assets and liabilities:

Accounts
receivable

(202,615

)

15,159

Inventories

(1,346,495

)

(438,560

)

Prepaid
expenses

(17,908

)

(725

)

Other
assets

948

(2,728

)

Accounts
payable

200,519

(18,477

)

Accrued
expenses and customer deposits

1,461,646

647,191

Net
cash provided by operating activities

456,770

134,788

CASH
FLOWS FROM INVESTING ACTIVITIES

Proceeds
on sale of equipment

-

750

Purchases
of property and equipment

(43,870

)

(59,368

)

Net
cash used in investing activities

(43,870

)

(58,618

)

CASH
FLOWS FROM FINANCING ACTIVITIES

Proceeds
from exercise of common stock options

-

4,200

Principal
payments on capital lease obligations and notes payable

(159,631

)

(189,957

)

Net
cash used in financing activities

(159,631

)

(185,757

)

NET
INCREASE (DECREASE) IN CASH

253,269

(109,587

)

CASH
- Beginning of period

730,352

997,170

CASH
- End of period

$

983,621

$

887,583

SUPPLEMENTAL
DISCLOSURES OF CASH

FLOW
INFORMATION

Cash paid
during the period for:

Interest

$

22,420

$

23,159

Income
taxes

948

43

SUPPLEMENTAL
DISCLOSURES OF NONCASH

INVESTING
AND FINANCING ACTIVITIES

Property
and equipment purchased by capital lease

103,550

145,077

Increase
in asset retirement obligation

609

-

The
accompanying notes are an integral part of these financial statements.

6

SCI
ENGINEERED MATERIALS, INC

NOTES
TO FINANCIAL STATEMENTS

Note
1.

Business
Organization and Purpose

SCI
Engineered Materials, Inc. (“SCI”, or the “Company”), formerly Superconductive Components, Inc., an Ohio
corporation, was incorporated in 1987. The Company operates in one segment as a global supplier and manufacturer of advanced
materials for Physical Vapor Deposition (“PVD”) Thin Film Applications. The Company is focused on specific markets
within the PVD industry (Photonics, Thin Film Solar, Glass, Thin Film Battery and Transparent Electronics). Substantially
all of the Company’s revenues are generated from customers with multi-national operations. Through collaboration with
end users and Original Equipment Manufacturers the Company develops innovative customized solutions enabling commercial success.

Note
2.

Summary
of Significant Accounting Policies

The
accompanying unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles
for interim financial information and with instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments considered necessary for fair presentation of the results of operations
for the periods presented have been included. The financial statements should be read in conjunction with the audited financial
statements and the notes thereto for the year ended December 31, 2016. Interim results are not necessarily indicative of results
for the full year.

The
preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Note
3.

Common
Stock and Stock Options

Stock
Based Compensation - Compensation cost for all stock awards is based on the grant date fair value and recognized over the required
service (vesting) period. Non cash stock based compensation expense was $50,669 and $51,532 for the three months ended June 30,
2017 and 2016, respectively. Non cash stock based compensation expense was $97,531 and $105,103 for the six months ended June
30, 2017 and 2016, respectively. Unrecognized compensation expense was $80,120 as of June 30, 2017 and will be recognized through
2019. There was no tax benefit recorded for this compensation cost as the expense primarily relates to incentive stock options
that do not qualify for a tax deduction until, and only if, a qualifying disposition occurs.

The
non-employee Board members received compensation of 44,623 and 31,682 aggregate shares of common stock of the Company during the
six months ended June 30, 2017 and 2016, respectively. The stock had an aggregate value of $37,486 and $24,358 for the six months
ended June 30, 2017 and 2016, respectively, and was recorded as non-cash stock compensation expense in the financial statements.

During
the second quarter of 2016, proceeds of $4,200 were received from the exercise of 5,000 stock options.

7

SCI
ENGINEERED MATERIALS, INC

NOTES
TO FINANCIAL STATEMENTS

Note
3.

Common
Stock and Stock Options (continued)

The
cumulative status of options granted and outstanding at June 30, 2017, and December 31, 2016, as well as options which became
exercisable in connection with the Company’s stock option plans is summarized as follows:

Employee
Stock Options

Weighted

Average

Stock
Options

Exercise
Price

Outstanding at January 1,
2016

572,857

$

4.27

Expired

(31,000

)

3.25

Exercised

(5,000

)

0.84

Forfeited

(139,186

)

4.29

Outstanding at December
31, 2016

397,671

$

4.39

Outstanding at
June 30, 2017

397,671

$

4.39

Options exercisable at December 31, 2016

267,668

$

5.07

Options exercisable at June 30, 2017

294,818

$

5.16

There
were no non-employee director stock options granted or outstanding during 2016 and 2017.

Exercise
prices for options ranged from $0.84 to $6.00 at June 30, 2017. The weighted average option price for all options outstanding
at June 30, 2017, was $4.39 with a weighted average remaining contractual life of 3.3 years.

Note
4.

Preferred
Stock

Dividends
on the Series B preferred stock accrue at 10% annually on the outstanding shares. Dividends on the Series B preferred stock were
$6,038 for the three months ended June 30, 2017 and 2016 and $12,076 for the six months ended June 30, 2017 and 2016. The Company
had accrued dividends on Series B preferred stock of $253,596 at June 30, 2017, and $241,520 at December 31, 2016. These amounts
are included in Convertible preferred stock, Series B on the balance sheet at June 30, 2017 and December 31, 2016.

Note
5.

Inventories

Inventories consisted of the following:

June
30,

December
31,

2017

2016

(unaudited)

Raw materials

$

1,260,147

$

110,752

Work-in-process

448,584

249,057

Finished goods

81,965

84,392

Inventory
reserve

(67,640

)

(67,640

)

$

1,723,056

$

376,561

The
inventory increase was due to orders received during the first half of 2017 that are expected to ship during the second half of
2017. Much of the increase was at the request of customers and prepayment was received to cover the cost of the inventory. A corresponding
increase in customer deposits appears on the balance sheet at June 30, 2017.

8

SCI
ENGINEERED MATERIALS, INC

NOTES
TO FINANCIAL STATEMENTS

Note
6.

Earnings
Per Share

Basic
income per share is calculated as income applicable to common shareholders divided by the weighted average of common shares outstanding.
Diluted earnings per share is calculated as diluted income applicable to common shareholders divided by the diluted weighted average
number of common shares. Diluted weighted average number of common shares gives effect to all dilutive potential common shares
outstanding during the period using the treasury stock method and convertible preferred stock using the if-converted method. Diluted
earnings per share exclude all diluted potential shares if their effect is anti-dilutive. For the three and six months ended June
30, 2017 and 2016, all convertible preferred stock and common stock options listed in Note 3 that were out-of-the-money or anti-dilutive
were excluded from diluted earnings per share. The following is provided to reconcile the earnings per share calculations:

Three
months ended June 30,

Six months
ended June 30,

2017

2016

2017

2016

Income (loss) applicable

to common shares

$

63,283

$

(183,339

)

$

16,797

$

(420,266

)

Weighted average common

shares outstanding - basic

4,125,880

4,042,722

4,114,756

4,033,488

Effect of dilution

-

-

-

-

Weighted average

shares outstanding - diluted

4,125,880

4,042,722

4,114,756

4,033,488

Note
7.

Notes
Payable

During
2010, the Company applied and was approved for a 166 Direct Loan to borrow up to $744,250 with the Ohio Department of Development
(ODOD), now known as the Ohio Development Services Agency (ODSA). This loan was finalized in February 2011. The term of the loan
is 84 months at a fixed interest rate of 3%. There is also a 0.25% annual servicing fee charged monthly on the outstanding principal
balance. Currently, monthly payments of approximately $10,400, including principal, interest and servicing fee are due through
October 2018. A final payment of approximately $71,900 is due November 2018. The loan is collateralized by the related project
equipment. As of June 30, 2017 there was an outstanding balance of $231,093 on this loan. Debt issuance costs of $2,236 are netted
against this amount for presentation in the financial statements. This loan is also subject to certain covenants, including job
creation and retention. On July 21, 2014, the Company and ODSA signed a second amendment relating to the job creation and retention.
The Company expects to maintain compliance with all covenants of this loan through at least June 30, 2018.

During
2010, the Company also applied and was approved for a 166 Direct Loan through the Advanced Energy Program with the Ohio Air Quality
Development Authority (OAQDA) to borrow up to approximately $1.4 million (this maximum commitment by the OAQDA was subsequently
reduced to $368,906 on March 20, 2012). Currently, quarterly payments of approximately $17,300, including principal, interest
at 3% and servicing fees are due through December 2017. A final payment of approximately $50,400 is due February 2018. This loan
is also subject to certain covenants, including job creation. Included in the above amendment is a waiver for the job creation
commitment, due to market conditions, for the duration of the term of the Loan Agreement. On July 21, 2016, OAQDA and the Company
signed a Fifth Amendment to the Loan Documents and

9

SCI
ENGINEERED MATERIALS, INC

NOTES
TO FINANCIAL STATEMENTS

Note
7.

Notes
Payable (continued)

agreed
to the elimination of a financial covenant. The loan is collateralized by the related project equipment. As of June 30, 2017 there
was an outstanding balance of $82,404 on this loan. Debt issuance costs of $3,271 are netted against this amount for presentation
in the financial statements. The Company expects to maintain compliance with all covenants of this loan through the remainder
of the loan.

An
Intercreditor Agreement exists as part of the above mentioned loans with agencies of the State of Ohio. The OAQDA and ODSA agree
to shared lien and security interest through mutual covenants. These covenants include, but are not limited to, the creation of
an agreed upon number of jobs, filing of quarterly and annual reports and various financial covenants.

The
Company was in compliance with all covenants of these loans at June 30, 2017. It is possible that the Company may not be in compliance
with all covenants in future periods. In the past the lenders have granted the Company a waiver or amendment when relief was sought.
If non-compliance is possible the Company will seek a waiver or amendment.

Note
8.

Income
Taxes

Following
is the income tax expense for the three and six months ended June 30:

Three
months ended

Six months
ended

June
30,

June
30,

2017

2016

2017

2016

Federal - deferred

$

-

$

-

$

-

$

-

State
and local

948

43

948

43

$

948

$

43

$

948

$

43

Deferred
tax assets and liabilities result from temporary differences in the recognition of income and expense for tax and financial reporting
purposes. A full valuation allowance has been recorded against the realizability of the net deferred tax assets at June 30, 2017
and December 31, 2016. The Company has net operating loss carryforwards available for federal and state tax purposes
of approximately $5,200,000 which expire in varying amounts through 2036.

Note
9.

Liquidity

Management
has forecasted revenues and related costs as well as investing plans and financing needs to determine liquidity to meet cash
flow requirements and believes the Company will have sufficient liquidity at least through August 2, 2018. This forecast
was based on current cash levels and debt obligations, and the best estimates of revenues primarily from existing customers and
gave consideration to the continued and possible increased levels of uncertainty in demand in the markets in which the Company
operates. The Company’s ability to maintain current operations is dependent upon its ability to achieve these
forecasted results, which the Company believes will occur.

10

Item
2.

Management's
Discussion and Analysis of Financial Condition and Results of Operations

The
following discussion should be read in conjunction with the Financial Statements and Notes contained herein and with those in
our Form 10-K for the year ended December 31, 2016.

Except
for the historical information contained herein, the matters discussed in this Quarterly Report on Form 10-Q include certain forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended, which are intended to be covered by the safe harbors created thereby. Those statements include, but may
not be limited to, all statements regarding our intent, belief, and expectations, such as statements concerning our future profitability
and operating and growth strategy. Words such as “believe,” “anticipate,” “expect,” “will,”
“may,” “should,” “intend,” “plan,” “estimate,” “predict,”
“potential,” “continue,” “likely” and similar expressions are intended to identify forward-looking
statements. Investors are cautioned that all forward-looking statements contained in this Quarterly Report on Form 10-Q and in
other statements we make involve risks and uncertainties including, without limitation, the factors set forth under the caption
“Risk Factors” included in our Annual Report on Form 10-K for the year ended December 31, 2016, and other factors
detailed from time to time in our other filings with the Securities and Exchange Commission. One or more of these factors have
affected, and in the future could affect our business and financial condition and could cause actual results to differ materially
from plans and projections. Although we believe the assumptions underlying the forward-looking statements contained herein are
reasonable, there can be no assurance that any of the forward-looking statements included in this Quarterly Report on Form 10-Q
will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein,
the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and
plans will be achieved.

Any
forward-looking statement speaks only as of the date on which such statement is made, and we undertake no obligation to update
any forward-looking statement or statements to reflect events or circumstances after the date on which such statements are made
or reflect the occurrence of unanticipated events, unless necessary to prevent such statements from becoming misleading. New factors
emerge from time to time and it is not possible for us to predict all factors, nor can it assess the impact of each such factor
on the business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from
those contained in any forward-looking statements.

Overview

SCI
Engineered Materials, Inc. (“SCI”, “we” or the “Company”), formerly Superconductive Components,
Inc., an Ohio corporation, was incorporated in 1987. We operate in one segment as a global supplier and manufacturer of
advanced materials for Physical Vapor Deposition (“PVD”) Thin Film Applications. We are focused on specific
markets within the PVD industry (Photonics, Thin Film Solar, Glass, Thin Film Battery and Transparent Electronics). Substantially
all of our revenues are generated from customers with multi-national operations. We have made considerable resource investment
in the Thin Film Solar industry and a few customers have adopted our products. Thin Film Battery is a developing market
where manufacturers of batteries use our products to produce very small power supplies with small quantities of stored energy.
Through collaboration with end users and Original Equipment Manufacturers we develop innovative customized solutions enabling
commercial success.

11

Item
2.

Management's
Discussion and Analysis of Financial Condition and Results of Operations (continued)

Executive
Summary

For
the six months ended June 30, 2017, we had total revenue of $3,283,414. This was an increase of $702,118, or 27.2%, compared to
the six months ended June 30, 2016. Gross profit was $799,832 for the six months ended June 30, 2017 compared to $546,469 for
the same six months in 2016. This was an increase of $253,363 or 46.4%. Gross profit as a percentage of revenue was 24.4% for
the first six months of 2017 compared to 21.2% for the same period in 2016. Pricing and product mix in our photonics market contributed
to the increased revenue and gross profit.

Operating
expenses were $747,807 and $931,775 for the six months ended June 30, 2017 and 2016, respectively. This was a decrease of $183,968
or 19.7%. The decrease was primarily related to the restructuring of our sales department late in 2016 and additional cost cutting
measures which were implemented during the second half of 2016.

We
have new materials under development that may replace the Cadmium Sulfide buffer layer in Copper Indium Gallium Selenide (CIGS)
solar cells. These materials are currently being tested at Case Western Reserve University. We continue to invest in developing
new products for all of our markets including transparent conductive oxide systems for the thin film solar and display markets.
We also have ongoing development efforts with our thin film battery materials and transparent electronic products. These efforts
include accelerating time to market for those products and involve research and development expense.

For
the six months ended June 30, 2017, we had net income after income taxes of $28,873 compared to a net loss of $408,190 for the
six months ended June 30, 2016. This improvement was due to the increased gross profit and the reduction in operating expenses.

RESULTS
OF OPERATIONS

Three
and six months ended June 30, 2017 (unaudited) compared to three and six months ended June 30, 2016 (unaudited):

Revenue

For
the three months ended June 30, 2017, we had total revenue of $1,911,498. This was an increase of $705,014, or 58.4%, compared
to the three months ended June 30, 2016. For the six months ended June 30, 2017, we had total revenue of $3,283,414 compared to
$2,581,296 for the same period in 2016. This was an increase of $702,118, or 27.2%. Pricing and product mix in our photonics market
contributed to the increased revenue and gross profit.

Revenue
from product sales is recognized based on shipping terms or upon shipment to customers. Provisions for discounts and rework costs
for returns are established when products are shipped based on historical experience. Customer deposits represent cash received
in advance of revenue earned.

Gross
Profit

Gross
profit was $462,847 for the three months ended June 30, 2017 compared to $286,859 for the same three months in 2016. This was
an increase of $175,988 or 61.4%. Gross profit as a percentage of revenue (gross margin) was 24.2% for the second quarter of 2017
compared to 23.8% for the same period in 2016. Gross profit was $799,832 for the six months ended June 30, 2017 compared to $546,469
for the first six months of 2016. This was an increase of $253,363 or 46.4%. Gross margin was 24.4% for the first six months of
2017 compared to 21.2% for the same period in 2016. The increase in gross profit and gross margin was attributed to pricing and
improved product mix.

12

Item
2.

Management's
Discussion and Analysis of Financial Condition and Results of Operations (continued)

General
and Administrative Expense

General
and administrative expense for the three months ended June 30, 2017 decreased to $256,112 from $273,712 for the three months ended
June 30, 2016, or 6.4%. This decrease was primarily related to lower compensation due to cost cutting measures.

General
and administrative expense for the six months ended June 30, 2017 decreased to $510,550 from $563,440 for the six months ended
June 30, 2016, or 9.4%. The first six months of 2017 included lower compensation of approximately $35,000 related to the previously
mentioned cost cutting measures and also lower professional fees of approximately $7,000.

We
reclassified a portion of rent expense from operating expenses (general and administrative) to cost of goods sold to
accurately reflect an amount assigned to the manufacturing area of our facility. This was retroactively reclassified
beginning January 1, 2016.

Professional
Fees

Included
in general and administrative expense was $41,688, and $43,491 for professional fees for the three months ended June 30, 2017
and 2016, respectively and $97,232 and $104,528 for professional fees for the six months ended June 30, 2017 and 2016, respectively.
These continued expenses are primarily related to SEC compliance costs for legal, accounting and stockholder relations fees.

Research
and Development Expense

Research
and development expense for the three months ended June 30, 2017 was $79,175 compared to $74,417 for the same period in 2016,
an increase of 6.4%. Research and development expense for the six months ended June 30, 2017 was $161,787 compared to $154,493
for the same period in 2016, an increase of 4.7%. We continue to invest in developing new products for all of our markets including
the buffer layer in CIGS solar cell, transparent conductive oxide systems for applications in transparent electronics, thin film
solar markets and ongoing development of thin film battery materials. These efforts include accelerating time to market for those
products and involve ongoing research and development expense.

Marketing
and Sales Expense

Marketing
and sales expense was $46,581 and $104,832 for the three months ended June 30, 2017 and 2016, respectively. This was a decrease
of $58,251 or 55.6%. We restructured our sales department during the fourth quarter of 2016 for improved efficiency. This action
resulted in lower stock compensation expense of approximately $10,000, consulting expense of approximately $24,000 as well as
lower wages and compensation of approximately $35,000.

Marketing
and sales expense was $75,470 and $213,842 for the six months ended June 30, 2017 and 2016, respectively. This was a decrease
of $138,372 or 64.7%. The first six months of 2017 resulted in lower stock compensation expense of approximately $21,000, consulting
expense of approximately $50,000 as well as lower wages and compensation of approximately $74,000.

13

Item
2.

Management's
Discussion and Analysis of Financial Condition and Results of Operations (continued)

Stock
Compensation Expense

Included
in operating expenses were non-cash stock based compensation costs of $50,187 and $51,049 for the three months ended June 30,
2017 and 2016, respectively and $96,565 and $104,138 for the six months ended June 30, 2017 and 2016, respectively. Compensation
cost for all stock-based awards is based on the grant date fair value and recognized over the required service (vesting) period.
Unrecognized non-cash stock based compensation expense related to operating expense was $75,614 as of June 30, 2017 and will be
recognized through 2019.

Interest

Interest
was $10,710 and $11,156 for the three months ended June 30, 2017 and 2016, respectively. Interest was $22,204 and $22,841 for the
six months ended June 30, 2017 and 2016, respectively.

Income
(loss) Applicable to Common Stock

Income
applicable to common stock for the three months ended June 30, 2017 was $63,283 compared to a loss applicable to common stock
of $183,339 for the three months ended June 30, 2016. Income applicable to common stock for the six months ended June 30, 2017
was $16,797 compared to a loss applicable to common stock of $420,266 for the six months ended June 30, 2016. The improvement
was due to higher revenue and gross profit as well as lower operating expenses.

Common
Stock

The
following schedule represents our outstanding common stock during the period of 2017 through 2024 assuming all outstanding stock
options are exercised during the year of expiration. Based on outstanding shares at June 30, 2017, if each shareholder exercises
his or her options, it would increase our common shares by 397,671 to 4,533,098 by December 31, 2024. Assuming all such options
are exercised in the year of expiration, the effect on shares outstanding is illustrated as follows:

Options
due to expire

Potential
shares outstanding

Weighted
average exercise price

2018

5,000

4,140,427

$

3.10

2019

271,500

4,411,927

$

6.00

2024

121,171

4,533,098

$

0.84

Liquidity
and Capital Resources

Cash

As
of June 30, 2017 cash on hand was $983,621. Cash on-hand was $730,352 at December 31, 2016. We believe, based on forecasted
sales and expenses that cash flow from operations will be adequate to sustain operations at least through August 2,
2018.

Working
Capital

At
June 30, 2017 working capital was $651,371 compared to $531,654 at December 31, 2016, an increase of $119,717 or 22.5%. As discussed
below, cash increased approximately $253,000. Inventories increased approximately $1,346,000 and customer deposits increased approximately
$1,471,000 due to orders received during the first half of 2017. Accounts receivable and accounts payable increased approximately
$203,000 and $201,000 respectively. Current debt obligations increased approximately $38,000 from $293,791 to $331,589.

14

Item
2.

Management's
Discussion and Analysis of Financial Condition and Results of Operations (continued)

Cash
from Operations

Net
cash provided by operating activities was approximately $457,000 for the six months ended June 30, 2017 and approximately $135,000
for the six months ended June 30, 2016. Included in expenses were non cash stock based compensation costs of approximately $98,000
and $105,000 for the six months ended June 30, 2017 and 2016, respectively.

Cash
from Investing Activities

Cash
of approximately $44,000 was used in investing activities during the six months ended June 30, 2017, compared to approximately
$59,000 during the six months ended June 30, 2016.

Cash
from Financing Activities

Cash
of approximately $160,000 and $190,000 was used in financing activities for principal payments to third parties for capital lease
obligations and notes payable during the six months ended June 30, 2017 and 2016, respectively. During the second quarter of 2016,
proceeds of $4,200 were received from the exercise of stock options.

Debt
Outstanding

Total
debt outstanding decreased to approximately $689,000 at June 30, 2017, from approximately $741,000 at December 31, 2016, or 7.0%.
Debt issuance costs of $5,506 at June 30, 2017, and $10,226 at December 31, 2016, are netted for financial statement presentation.
During the first quarter of 2017 we closed on a new capital lease obligation of approximately $104,000. During the second quarter
of 2016 we closed on a new capital lease obligation of approximately $145,000.

Liquidity

We
have forecasted revenues and related costs as well as investing plans and financing needs to determine liquidity to meet
cash flow requirements and believe we will have sufficient liquidity at least through August 2, 2018. This forecast was
based on current cash levels and debt obligations, and the best estimates of revenues primarily from existing customers and gave
consideration to the continued and possible increased levels of uncertainty in demand in the markets in which we operate. Our
ability to maintain current operations is dependent upon our ability to achieve these forecasted results, which we believe will
occur.

Off
Balance Sheet Arrangements

We
have no off balance sheet arrangements including special purpose entities.

15

Item
2.

Management's
Discussion and Analysis of Financial Condition and Results of Operations (continued)

Critical
Accounting Policies

The
preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the
United States requires management to make judgments, assumptions and estimates that affect the amounts reported in the Financial
Statements and accompanying notes. Note 2 to the Financial Statements in our Annual Report on Form 10-K for the year ended
December 31, 2016, describes the significant accounting policies and methods used in the preparation of the Financial Statements.
Estimates are used for, but not limited to, accounting for the allowance for doubtful accounts, inventory allowances, property
and equipment depreciable lives, patents and licenses useful lives, revenue recognition, tax valuation allowance, stock based
compensation and assessing changes in which impairment of certain long-lived assets may occur. Actual results could differ from
these estimates. The following critical accounting policies are impacted significantly by judgments, assumptions and estimates
used in the preparation of the Financial Statements. The allowance for doubtful accounts is based on our assessment of the collectability
of specific customer accounts and the aging of the accounts receivable. If there is a deterioration of a major customer’s
credit worthiness or actual defaults are higher than our historical experience, our estimates of the recoverability of amounts
due us could be adversely affected. Inventory purchases and commitments are based upon future demand forecasts. If there is a
sudden and significant decrease in demand for our products or there is a higher risk of inventory obsolescence because of rapidly
changing technology and customer requirements, we may be required to increase our inventory allowances and our gross margin could
be adversely affected. Depreciable and useful lives estimated for property and equipment, licenses and patents are based on initial
expectations of the period of time these assets and intangibles will benefit us. Changes in circumstances related to a change
in our business, change in technology or other factors could result in these assets becoming impaired, which could adversely affect
the value of these assets.

Item
4.

Controls
and Procedures

Evaluation
of Disclosure Controls and Procedures

Our
management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by
this report. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures,
no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives and
management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Due to a segregation of duties material weakness described below, and based on this evaluation, the Company’s Chief Executive
Officer and Chief Financial Officer have concluded that as of June 30, 2017, the Company’s disclosure controls and procedures
were not effective, at the reasonable assurance level, in recording, processing, summarizing and reporting, on a timely basis,
information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act and in ensuring
that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is accumulated
and communicated to the Company’s management, including the Chief Executive Officer and Chief Accounting Officer, as appropriate
to allow timely discussions regarding required disclosure. Until we are able to hire additional employees, we will continue to
report to the Audit Committee and the Board of Directors at least monthly (and more often as necessary). We believe this will
continue to mitigate this weakness. This reporting includes balance sheets, statements of operations, statements of cash flows,
and other detail supporting these statements. Accordingly, we believe that the financial statements included in this report fairly
present, in all material respects, our financial condition, results of operation, changes in shareholder’s equity and cash
flows for all periods presented.

16

Item
4.

Controls
and Procedures (continued)

Inherent
Limitations over Internal Controls

Our
internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Our internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records
that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management
and directors; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use,
or disposition of assets that could have a material effect on the financial statements.

Management,
including our Chief Executive Officer and Chief Financial Officer, does not expect that our internal controls will prevent or
detect all errors and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the
fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of internal controls can provide absolute assurance that all control
issues and instances of fraud, if any, have been detected. Also, any evaluation of the effectiveness of controls in future periods
is subject to the risk that those internal controls may become inadequate because of changes in business conditions or that the
degree of compliance with the policies or procedures may deteriorate.

Management
previously disclosed a material weakness in internal control over financial reporting in its annual report on Form 10-K, filed
on February 27, 2017, for the year ended December 31, 2016, relating to insufficient segregation of duties consistent with control
objectives. Management is aware of the risks associated with the lack of segregation of duties due to the small number of employees
currently working with general administrative and financial matters. Due to our size and nature, segregation of all conflicting
duties may not always be possible and may not be economically feasible. However, to the extent possible, the initiation of transactions,
the custody of assets and the recording of transactions shall be performed by separate individuals. In order to remediate this
weakness, we will need to hire additional employees. Although we will periodically reevaluate this situation, at this point we
consider that the risks associated with such lack of segregation of duties and the potential benefits of adding employees to segregate
such duties are not cost justified. Until we are able to hire additional employees, we will continue to report to the Audit Committee
and the Board of Directors at least monthly (and more often as necessary). We believe this will continue to mitigate this weakness.
This reporting includes balance sheets, statements of operations, statements of cash flows, and other detail supporting these
statements.

Changes
in Internal Controls over Financial Reporting

There
were no changes in our internal controls over financial reporting for the three months ended June 30, 2017, that materially affected
or were reasonably likely to materially affect our disclosure controls and procedures. Additionally, there were no changes in
our internal controls that could materially affect our disclosure controls and procedures subsequent to the date of their evaluation.

17

Part
II. Other Information

Item
6.

Exhibits

3.1

Certificate
of Second Amended and Restated Articles of Incorporation of Superconductive Components,
Inc. (Incorporated by reference to Exhibit 3(a) to the Company’s initial Form 10-SB,
filed on September 28, 2000)

3.2

Restated
Code of Regulations of Superconductive Components, Inc. (Incorporated by reference to
Exhibit 3(b) to the Company’s initial Form 10-SB, filed on September 28, 2000)

3.3

Amendment
to Articles of Incorporation recording the change of the corporate name to SCI Engineered
Materials, Inc. (Incorporated by reference to Exhibit 3.1 to the Company’s Quarterly
Report on Form 10-QSB filed November 7, 2007).

4.1

SCI
Engineered Materials, Inc. 2011 Stock Incentive Plan (Incorporated by reference to the
Company’s Definitive Proxy Statement for the 2011 Annual Meeting of Shareholders
held on June 10, 2011, filed April 28, 2011).

4.2

Superconductive
Components, Inc. 2006 Stock Incentive Plan (Incorporated by reference to Appendix A to
the Company’s Definitive Proxy Statement for the 2006 Annual Meeting of Shareholders
held on June 9, 2006, filed May 1, 2006).

4.3

Description
of the Material Terms of the Stock Option Grant and Cash Bonus Plan for Executive Officers
(Incorporated by reference to the Company’s Current Report on Form 8-K, dated June
19, 2006, filed June 23, 2006)

4.4

Form
of Incentive Stock Option Agreement under the Superconductive Components, Inc. 2006 Stock
Incentive Plan (Incorporated by reference to Exhibit 10.1 to the Company’s Current
Report on Form 8-K dated June 19, 2006, filed June 23, 2006).

4.5

Form
of Non-Statutory Stock Option Agreement under the Superconductive Components, Inc. 2006
Stock Incentive Plan (Incorporated by reference to Exhibit 10.2 to the Company’s
Current Report on Form 8-K dated June 19, 2006, filed June 23, 2006).

4.6

Description
of the Material Terms of the Stock Option Grant for Executive Officers and Board of Directors
(Incorporated by reference to the Company’s Current Report on Form 8-K dated January
2, 2009, filed January 6, 2009).

4.7

Fourth
Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 4(a)
to the Company’s Registration Statement on Form S-8 (Registration No. 333-97583),
filed on August 2, 2002)

4.8

Form
of Non-Statutory Stock Option Agreement Under the Superconductive Components, Inc. Fourth
Amended and Restated 1995 Stock Option Plan (Incorporated by reference to Exhibit 10.1
to the Company’s Current Report on Form 8-K, filed on December 22, 2005)

18

Item
6.

Exhibits
(continued)

10.1

Description
of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development
Authority (Incorporated by reference to the Company’s Current Report on Form 8-K,
filed March 26, 2012).

10.2

Description
of amendment to the Loan Agreement between the Company and the Ohio Department of Development
(Incorporated by reference to the Company’s Current Report on Form 8-K, filed April
9, 2012).

10.3

Description
of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development
Authority (Incorporated by reference to the Company’s Current Report on Form 8-K,
filed July 10, 2012).

10.4

Description
of amendment to the Loan Agreement between the Company and The Ohio Air Quality Development
Authority (Incorporated by reference to the Company’s Current Report on Form 8-K,
filed October 19, 2012).

10.5

Description
of amendment to the Loan Agreement between the Company and the Ohio Development Services
Agency, formerly known as the Ohio Department of Development (Incorporated by reference
to the Company’s Current Report on Form 8-K, dated March 19, 2013).

10.6

Description
of modification to payment schedules between the Company and the Ohio Development Services
Agency, formerly known as the Ohio Department of Development and Description of Business
Loan Agreement between the Company and The Huntington National Bank dated as of October
8, 2013 (Incorporated by reference to the Company’s Current Report on Form 8-K,
dated August 12, 2013).

10.7

Description
of amendment to Loan Documents between the Company and the Ohio Air Quality Development
Authority dated as of December 20, 2013 (Incorporated by reference to the Company’s
Current Report on Form 8-K, dated December 26, 2013).

10.8

Description
of amendment to the Loan Agreement between the Company and the Ohio Development Services
Agency, formerly known as the Ohio Department of Development (Incorporated by reference
to the Company’s Current Report on Form 8-K, dated July 24, 2014).

10.9

Description
of amendment to Loan Documents between the Company and the Ohio Air Quality Development
Authority dated as of July 21, 2016 (Incorporated by reference to the Company’s
Current Report on Form 8-K, dated July 22, 2016).

22.1

Description
of matters submitted to vote of security holders (Incorporated by reference to the Company’s
Current Report on Form 8-K, dated June 9, 2017).

The
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2017, formatted
in XBRL (eXtensible Business Reporting Language): (i) Consolidated Balance Sheets at
June 30, 2017 and December 31, 2016, (ii) Consolidated Statements of Operations for the
three and six months ended June 30, 2017 and 2016, (iii) Consolidated Statements of Cash
Flows for the six months ended June 30, 2017 and 2016, (iv) Notes to Financial Statements.*

*
Filed with this report

19

Signatures

Pursuant
to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned thereunto duly authorized.

SCI ENGINEERED MATERIALS,
INC.

Date: August
2, 2017

/s/
Daniel Rooney

Daniel Rooney, Chairman of the Board
of
Directors, President and Chief Executive Officer